Grey Fox Aviation Company is analyzing a project that requires an inital investm

Question

Grey Fox Aviation Company is analyzing a project that requires an inital investment of $400,000. The project's expected cash flows are:

Cash Flow

1. Grey Fox Aviation Company's WACC is 10%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR):
a. 21.99%
b. 25.87%
c. 24.58%
d. 27.16%

2. If Grey Fox Aviation Company's managers select projects based on the MIRR criterion, they should ________ (a. accept, b. reject) this independent project.

3. Which of the following statements best describes the difference between the IRR method and the MIRR method?
a. The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.
b. The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR.
c. The IRR method uses the present value of the initial investment to calculate the IRR. The MIRR method uses the terminal value of the initial investment to calculate the MIRR.

Cash Flow

Explanation / Answer

Answer-1 year Cash flows 0 -$400,000 1 $375,000 2 -$200,000 3 $450,000 4 $425,000 Initial investment = $400,000 WACC= 10% Modified internal rate of return, MIRR is calculated by this formula: MIRR = nth root of (Future value of positive cash flows/Present value of negative cash flows)   - 1 Here n = the number of years and present and future value would be calculated at Weighted average cost of capital. Here the positive cash flows are $375000, $450000 and $425000 and their present values are = year Cash flows Present value Future value 0 -$400,000 $400,000.00 1 $375,000 $499,125.00 2 -$200,000 $165,289.26 3 $450,000 $495,000.00 4 $425,000 $425,000.00 So the sum of PV of negatives = $565,289.26 the sum of FV of negatives = $1,419,125.00 therefore MIRR = 4th root of ($1419125/$565289.26)   -   1 = 0.258744 MIRR = 25.87% So the correct option is b. Answer-2 As the MIRR of 25.87% is greater than the WACC of 10% then we should accept this project. Answer-3 This best describle the MIRR method. a. The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.

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